Friday, January 16, 2015

Lawler: “Surprise” Warnings on Margins/Effective Prices Whacks Home Builder Stocks

by Bill McBride on 1/16/2015 04:05:00 PM

From housing economist Tom Lawler:

While two major home builders this week reported ‘ok” (KB Home) to better than consensus (Lennar) operating results for the quarter ended November 30, 2014, both home builders “stunned” many investors by warning that weaker than anticipated demand and “diminished” pricing power in several markets across the country had resulted in increased sales incentives and in some markets modest price reductions – developments which, when combined with continued increases in labor and material costs, would result in lower margins in FY 2015 compared to FY 2014. I say that many investors were “stunned” because home builder stocks took a savage beating this week, especially the stock of KB Home, whose ‘margin warning” was the most surprising.

KB Home
  Housing UnitsAverage Price
Qtr. Ended:11/30/201411/30/2013% Change11/30/201411/30/2013% Change
Net Orders1,7061,5569.6%$344,500 $309,600 11.3%
Deliveries2,2292,0389.4%$351,500 $301,100 16.7%
Backlog (EOQ)2,9092,55713.8%$314,200 $266,900 17.7%
Net Orders/Community7.978.19-2.7%     

Lennar Corporation
  Housing UnitsAverage Price
Qtr. Ended:11/30/201411/30/2013% Change11/30/201411/30/2013% Change
Net Orders5,4924,49822.1%$325,000 $320,000 1.6%
Deliveries6,9505,65023.0%$329,000 $308,000 6.8%
Backlog (EOQ)5,8324,80621.3%$339,000 $337,000 0.6%
Net Orders/Community98.73.4%     

In terms of unit sales guidance, KB Home said that it expected its community count to increase by 15-20% over the next year, and that it expected its order pace to track the increase in its community count. Lennar said that it expects home deliveries in FY 2015 to be between 12% and 14% above deliveries in FY 2014.

While most competent housing analysts had expected diminished price increases and increased sales incentives at most home builders in 2014 and 2015 following the surprising sharp price increases in 2013, the majority of housing analysts and investors had no such expectation. In the latter part of 2012 and the first half of 2013 many builders experienced a significant and unexpected increase in demand that outpaced their ability to finish homes (partly related to “supply-channel” issues), and in response many builders hiked prices substantially in order to keep demand on pace with their ability to produce homes. As builders’ ability to increase production increased in 2014, however, few builders responded by paring back prices or increasing incentives, and as a result overall unit sales lagged expectations. Another key factor in 2014 that kept demand below expectations was mortgage credit conditions – many analysts and builders had expected mortgage credit to be significantly less restrictive in 2014, but that was not the case for most of the year. Indeed, by some “metrics” mortgage credit was actually a bit “tighter” in the first half of 2014 than in 2013, in part reflecting lenders’ “adjustments” to the January implementation of the CFPB QM rules as well as its new servicing rules.

Yet another factor that appeared to contribute to lower than consensus new home sales last year was that many (though not all builders) were not very aggressive in opening and marketing communities designed for the “typical” first-time buyer (as opposed to the “high income/strong credit first-time and trade-up buyer), which generally have lower price points, fewer amenities, and lower margins than communities targeted to the “trade-up” buyers. The notion that new SF home building could start to return to “normal” levels while at the same time the elevated home sizes, prices, and margins would remain the same seemed silly, and in hindsight it was.

While the notion that builder margins will on average be lower in 2015 than the “higher than sustainable” levels in 2014 seems quite reasonable and was quite predictable, by the same token the outlook for improved sales volumes at lower margins/price points has improved. Obviously, of course, mortgage interest rates have come down; the FHA lowered its annual insurance premium by 50 bp; and it appears as if an increasing number of mortgage lenders have eased mortgage credit conditions/credit overlays in recent months. In addition, the overall US economy has continued to improve, as has the labor market – though more in terms of jobs than in terms of income growth, highlighting the need for lower price points for homes targeted for potential first-time buyers.
emphasis added